Bhel’s steep valuation prices in the potential positives

Shares of Bharat Heavy Electricals Ltd (Bhel), the state-owned power equipment firm, continued to rise, though its flash results declared last week showed a pathetic performance. The Rs.877 crore net loss for fiscal year 2016 was not only the decade’s first, but was steeper than what the Street expected. Further, it comes after a net profit of Rs.1,419 crore posted a year ago.

Perhaps the stock’s momentum is on the back of the 43% jump in order inflows for the full year. This implies a 51% rise in quarterly inflows. Note that the stock first rose from its slumber a few weeks ago, when a CLSA Research report sparked off investor interest by predicting a 40% jump in order inflows, on a reversal of the capex cycle.

But the complete audited results will influence sustained interest in the stock. For now, implied results for the March quarter (derived from the full-year flash results) show a 12% year-on-year drop in revenue and a 50% drop in net profit. This is hardly good news for investors.

According to analysts, the thing to look out for is gross margins. A Nomura Research report points out that Bhel’s gross margins may be weak in the medium term due to the increasing mix of super-critical orders, where there are obligations under a joint development undertaking, with its partner. Add to this the low-margin engineering, procurement, construction business whose share in recent orders is higher than earlier.

Moreover, Bhel has not been able to get out of the quagmire of high working capital requirement following project delays and low capacity utilization. With customers owing more than a year of sales to the firm (receivables), there could be some write-offs that will be a drag on future earnings.

In the interim, the hope is that the good news on order inflow growth continues in the forthcoming quarters. Concerns remain, as about two-fifths of FY16 orders were from Telangana, which might not be recurring in nature. Also, the power sector is not yet as vibrant as the roads segment and there has been little action in the private sector too. With a steep valuation of 25 times one-year forward estimated earnings, Bhel’s stock has priced in any potential upsides in performance already.

BHEL